Time to Bet on Japan Hedged Equity ETFs?
The Japanese economy – which was stalled out by the disaster caused by an earthquake and tsunami in March 2011 and a long-stretched deflationary rut – waited for a turnaround for quite some time and seems to have found it lately.
Along with ‘Abenomics’ – a reformative initiative introduced by the Prime Minister Shinzo Abe early this year– modest overseas recovery has also played a vital role in the nation’s recent outperformance.
Like several other developed nations, the key tool of the Japanese reform was the adoption of a massive monetary and fiscal stimulus scheme. The Bank of Japan follows a policy to increase Japan’s monetary base at an annual run of about 60–70 trillion yen.
This injection of artificial liquidity will continue until the inflation target reaches 2%. The overall recovery trail helped drive investors’ sentiment lately.
Weak Yen, Export Boom, Surging Market Steal the Show
Fortunately, the reformative measures paid off with the economy ending a long string of deflation in June this year. Also, as much as a 16% drop in Japanese currency (Yen) relative to the greenback so far this year triggered export growth in October leading share prices into a rally.
The benchmark Nikkei 225 Index reached a six-month peak on November 22 with some busy trading across the board. The benchmark Nikkei has gained an impressive 44% which was one of the best performances among major indices.
Expectations for corporate earnings are up thanks to a depreciation of the yen versus the dollar. The wakened currency basically raised Japanese companies’ export competitiveness, as per Reuters.
In fact, growing competition from Japanese suppliers armed by a weaker currency could be a reason for the weak show in the Chinese manufacturing data in November (read: iShares Files For 3 Currency Hedged ETFs).
The benefit gets realized even more when the companies operating abroad send the money earned in dollar terms back home. Japanese auto behemoths –Toyota Motor Corp. (TM) and Honda Motor Co Ltd(HMC) – are among the beneficiaries of this repatriation.
As if these were not enough, a low interest rate from ‘Abenomics’ helped create ripples in the property market of Japan as well as supported industrial growth which is reflective of the stock market gains.
What Lies Ahead?
The path ahead is mixed with possibilities and perils. On a positive note, Japanese equities presently carry a 12-month forward price-to-earnings of 14, as per Reuters.
Regardless of the recent rally, price-to-earnings ratio hovered below a 10-year average of 16.1 and most importantly, less expensive than the S&P 500’s 14.9 times (see Japan ETFs: Six Ways to Play the Surge).
On the flip side, the trade balance was unfavorable even after the inspiring export data in October as import growth was faster than that of exports. The import of fuels to make up for the collapse of its nuclear power industry hurt the trade balance figures.
While advanced nations contributed to Japan’s export profile, the numbers are still weak from emerging nations. The domestic demand profile is improving, but some feel that the trend might reverse with a national sales tax hike next April which in turn might cripple household spending.
The market expects the Japanese growth to pick up in the final quarter of the year assisted by a recovery in exports as well as private consumption prior to the sales tax hike.
Market Impact
Investors willing to seize the possibilities in one of fastest growing developed nations but avoid its tumbling currency, might consider some hedged Japan equity ETFs (read: WisdomTree Doubles Down on Hedged Japan ETF Lineup).
To name a few options, we have WisdomTree Japan Hedged Equity Fund (DXJ) and db X-trackers MSCI Japan Hedged Equity Fund (DBJP) both of which returned a minimum of 35% in the year-to-date frame and have positive Zacks ETF Ranks #2 (Buy).
WISDOMTREE JAPAN HEDGED EQUITY FUND (DXJ)
Launched in June 2006, DXJ looks to track the WisdomTree Japan Hedged Equity Index and offer investors a way to gain exposure to Japanese shares devoid of currency risks. This is a liquid choice in the space with 6,500,000 shares in average trading volume a day.
The large-cap oriented fund has a huge asset base of $11.2 billion and charges 48 bps in fees (see DXJ vs. DBJP: Which is the Better Hedged Japan ETF?). With a total of 313 holdings in its basket, the top 10 stocks contribute around 35% of the total assets calling for decent concentration risks.
Mitsubishi, Toyota Motor and Canon take the top three spots of the fund. Growth stocks account for just one-third of the total fund signaling stability in the product.
db X-trackers MSCI Japan Hedged Equity Fund (DBJP)
Launched in June 2011, DBJP tracks the MSCI Japan US Dollar Hedged Index offering exposure to Japan and a hedge against any fall in the currency (against the dollar). It is a bit overlooked choice in the space with only $245.5 million in AUM and about 100,000 shares in average volume. The fund charges 50 bps in annual fees.
The product holds 321 stocks in total and its top 10 holdings contribute around 24% to the fund. Top three holdings include the surging Toyota, Mitsubishi and Softbank. Honda Motors occupies the third place. Notably, Softbank has been a star performer in the recent rally.
DBJP is governed by large cap stocks with a tilt toward growth stocks which account for around 43% of the product.
Bottom Line
The Japanese economy needs to do a lot more to alleviate all its issues. Things are mostly dependent on boarder market recovery as this regulates the country’s export profile as well as the pattern of domestic consumption.
The world’s third largest economy might succumb to a slowdown next year once the taper concern resumes in the U.S., if not later this month. Also, a slow recovery in Europe and China and domestic austerity measures may come in the way of a full-fledged economic revival.
Still, Japan’s future is relatively bright in the short term, and investors who think more yen losses are coming– but that stock prices in the nation can still rise– might be best served by looking at either of the aforementioned ETFs for exposure.
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DB-XT MS JAP HD (DBJP): ETF Research Reports
WISDMTR-J HEF (DXJ): ETF Research Reports
HONDA MOTOR (HMC): Free Stock Analysis Report
